Dan Walters: California’s tax system is out of whack

What happened – or, more accurately, what didn’t happen – to Senate Bill 30 this year is a perfect illustration of the Legislature’s endemic disconnection from real life.

Real life is that hundreds of thousands, if not millions, of California homeowners lost their homes to foreclosures and short sales when the housing bubble burst and a severe recession gripped the state.

Technically, mortgage debts that are forgiven are income to the ex-homeowners, but Congress recognized that taxing that phantom income would be wrong and created an exemption.

The Legislature followed suit vis-à-vis state income taxes, but the temporary state exemption expired at the end of 2012 and SB 30 would have reinstated it for an extra year.

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(The bill was being carried, it should be noted, by Sen. Ron Calderon, who is now embroiled in a federal bribery investigation, but that doesn’t taint this particular bill.)

SB 30 had no opposition and sailed through the Senate 36-0, but only after the Senate’s leadership inserted a “poison pill” into the measure. It declared that SB 30 could take effect only if another measure, Senate Bill 391, was enacted.

SB 391 did have opposition, principally from the California Association of Realtors. It would impose fees on real estate transactions to raise money for low-income housing.

The poison pill’s practical effect was to stop action on both bills in the Assembly. Thus, distressed homeowners will most likely be hit with income-tax bills for 2013, estimated at about $50 million in all.

Ultimately, playing political games was more important than doing the right thing by families that had lost their homes, and that’s shameful.

It is, however, just one – albeit major – component of an even larger issue, the increasingly wide gap in how federal and state income-tax systems calculate income and deductions.

Once, as Gina Rodriquez, vice president of the California Taxpayers Association, points out in a recent online article, the Legislature took great pains to align the two tax systems as much as possible for the convenience of taxpayers.

Typically, the Legislature would enact an omnibus “conformity bill” each year, but that practice ended about two decades ago and since then, tax conformity has been a hit-and-miss proposition and the systems have gotten out of alignment.

Thus, the disconnect that’s very evident on the treatment of phantom income on distressed homes is much more of a systemic shortcoming, and the Legislature is making life much more difficult for millions of California taxpayers than it should be.

Furthermore, Rodriquez rightly says that the misalignment of the two tax systems is another in a long string of issues that contribute to the state’s reputation for being an extraordinarily difficult place in which to do business.